Student Loan Default Explained
When you took out your student loan, you signed a promissory note and entered into a legally binding contract promising that you’d repay your lender when the time came. Well, the time has come. Now, what do you do to make sure you’re holding up your end of the bargain? Perhaps more importantly, what can you do if you can’t meet your obligation?
Delinquent vs Default: What’s in a Name?
The very first time you miss a payment – even just by a day or two – your loan is considered delinquent.
It will remain delinquent until you make up all your missed payments or receive a deferment (a temporary postponement of your payments) or forbearance (a temporary suspension or reduction of your payment). If your loan is delinquent for 90 days or more, your loan servicer will report the delinquency to the three major national credit bureaus. Here’s when your credit score takes a hit.
If your loan continues in delinquency, it moves into default. At that point, you’ll lose eligibility to receive future student aid, and you might face serious legal repercussions.
The instant when a loan is considered in default depends on the type of loan. For most federal student loans, you’re in default if you haven’t made your scheduled payments for at least 270 days. For others, the loan issuer has the authority to declare the loan in default if you don’t make your scheduled payment by the due date.
The Effects of Default
The consequences of default can be severe. First and foremost, you face acceleration –your entire unpaid balance plus interest becomes due immediately. And if your monthly payment was too much, how will you ever handle paying the entire amount? Your lender may garnish your wages so that a portion of your paycheck goes to pay off your loan, or they may order a treasury offset so that your tax refunds are applied toward repayment. You could wind up in court facing even more bills such as court costs, collection fees, attorney’s fees, and more.
But the long-term results of default may be even more damaging: Your default is reported to the credit bureaus, damaging your credit rating and impeding your ability to get a mortgage, car loan, or a credit card. It can take years to reestablish good credit. Also, your school may withhold your academic transcript until your loan is satisfied – so what you worked so hard to achieve remains out of reach.
How to Avoid Defaulting
The most important thing to remember is that if you are having trouble making your monthly loan payments – or think you might run into trouble – you should contact your loan servicer immediately. Don’t wait until you’ve missed multiple payments to reach out and discuss your options. You’ll have more leverage to keep your loan in good standing if you’re up-front about your financial hardships from the start. In fact, you lose eligibility to apply for deferment, forbearance, or an alternate repayment plan if you go into default.
Depending on your situation and type of loan, you may be eligible for options such as:
- A change to your payment due date: Sometimes there’s an “easy” fix for making your monthly payment. If you find that your statements are hitting, say, right before payday, consider requesting a change to accommodate your bank account balance. This is usually a quick accounting switch that your lender should be fine with.
- An extended repayment plan: This gives you 25 years to pay off your loan instead of the standard 10 years. But keep in mind that your monthly payment will be lower, which means you’ll end up paying more over time because of the additional interest.
- An income-driven repayment plan: Your monthly payment will be a percentage of your discretionary income set at an affordable amount based on your income and family size. You’ll have 20 or 25 years (depending on the plan) to pay off your loan, and any balance remaining at the end of the repayment period is forgiven. You may have to pay income tax on any amount that is forgiven.
- A direct consolidation loan: If you’re carrying multiple federal student loans, apply for a consolidation loan that combines them into one new loan. This consolidation means you’ll end up with a single monthly payment and – possibly – an extended amount of time for the repayment of your balance.
Have you investigated these options and can’t quite figure out how to pull yourself out of default danger? Remember, you don’t have to struggle through this alone. Bring your lingering concerns or questions to American Credit Foundation. One of our financial experts will be happy to explain the options and help you determine which course of action is your best bet.